Corporations Code sections 800 and 5710 give shareholders and members standing to bring derivative claims, i.e. claims on behalf of the corporation. For example, if the board of directors steals money from the corporation’s bank account, shareholders and members can bring a derivative action on behalf of the corporation to recover the stolen money. However, a shareholder (or member) who files an action under section 800 (or section 5170) will lose standing to maintain the lawsuit if she stops being a shareholder (or member).
Nonprofit corporations, however, do not have shareholders. In some cases, nonprofits have “members” who function like shareholders and elect the directors. But many nonprofits have no members to oversee the board of directors. So who has standing to sue on behalf of the nonprofit when the directors are damaging the corporation? In addition to member derivative actions under section 5170, three sections of the Corporations Code authorize both the attorney general and other directors of the nonprofit to file suit.
First, section 5233, subdivisions (c) and (h), provides that the Attorney General or, if the Attorney General is joined as an indispensable party, a director of a nonprofit corporation “may bring an action” to remedy impermissible self-dealing by another director.
Second, section 5142, subdivision (a)(3), provides that a director of a nonprofit corporation “may bring an action to enjoin, correct, obtain damages for or to otherwise remedy a breach of a charitable trust.”
Finally, section 5223, subdivision (a), authorizes the superior court, “at the suit of a director” of a nonprofit corporation, to remove another director for, among other things, fraudulent or dishonest acts, gross abuse of authority, or breach of duty.
But what happens when the board removes a director after she files an action under these statutes? Does the director lose standing once she is removed (like shareholder standing under Corp. Code, § 800), or do the standing requirements only apply at the time the director files suit?
The Court of Appeal recently considered this question in Summers v. Collette, (2019) 34 Cal.App.4th 361. Summers and Collette were both directors of a nonprofit corporation. Summers accused Collette of breaching her fiduciary duties to the nonprofit, and she sued Collette on behalf of the corporation. After Summer filed her lawsuit, the board removed her as a director and the trial court then dismissed the case, reasoning that Summer lost standing when she was removed. The Court of Appeal considered whether, in a director’s action under sections 5223, 5233, and 5142, removing the director who brought the action deprives her of standing to continue to pursue it.
The court first examined the statutory language and found meaningful differences between the standing requirements for nonprofit directors (Corp. Code, §§ 5223, 5233 & 5142), and the derivative standing required for shareholders (Corp. Code, § 800) or members of nonprofits (Corp. Code, § 5170). Unlike the statutes for nonprofit directors, sections 800 and 5170 both provide that “[n]o action may be instituted or maintained” if the plaintiff is not a shareholder or member.
Significantly, the “instituted or maintained” language that the Supreme Court concluded suggested a continuous stock ownership requirement in section 800, and which appears in the provision concerning a member’s standing to bring an action on behalf of a nonprofit corporation in section 5710, does not appear in the provision governing a director’s standing to bring an action on behalf of a nonprofit in sections 5233 and 5142. That difference in language suggests a difference in legislative intent. … In particular, the absence of something comparable to the phrase “or maintained” in sections 5233 and 5142 points away from a continuous directorship requirement in the same way that phrase’s presence in section 800 “point[s] to” a continuous stock ownership requirement.
In addition to the statutory text, the court also cited important public policy reasons for conferring standing on nonprofit directors, even if they are removed after they file suit.
As the Supreme Court observed in Holt, a “‘charity’s own representative has at least as much interest in preserving the charitable funds as does the Attorney General who represents the general public.’” Such an individual “‘is also in the best position to learn about breaches of trust and to bring the relevant facts to a court’s attention.’” A director who files an action such as this one will continue to provide the advantages identified in Holt even if later removed from office.
This seems like the right result, but there are still questions that remain unanswered. The court did not directly address whether a nonprofit director would still have standing to sue if the corporation removes her from the board after she complains about wrongful conduct but before she has time to file a lawsuit. If the plaintiff must be a director when the action is filed, every board majority (even those who have done nothing wrong) will have a strong incentive to immediately remove any director who complains before she has a chance to sue.